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June 4, 2012

Solving America’s Income-Deficit Problem

Social Security now pays out more in benefits than it receives in payroll taxes. What does that mean for your clients' portfolio plans?

Social Security is on pace to exhaust its reserves by 2033, and it’s not the solution to the income shortage facing the American public.

Today, 56 million Americans rely on Social Security and they receive an average monthly check of $1,125. Sadly, this monthly sum is the only source of income for the vast majority.

Contrary to popular opinion, Social Security was not created because of public demand or need.

“It was sold by the slickest devices of Madison Avenue,” stated Milton Friedman, a Nobel Prize winning economist.

Friedman observed how the very language behind Social Security is “misleading.”

For instance, the payments that Social Security recipients receive are commonly referred to as “benefits,” but the truth is they are subsidies. Here’s what’s really occurring: Younger tax payers, via Social Security taxes, are subsidizing the payments received by retirees.

On July 28, 2012, the Social Security system celebrated 75-years of existence. And while politicians celebrated on the House steps of the Capitol and bragged about the financial soundness of the system, there was no mention of another important milestone achieved by Social Security: It now pays out more in benefits than it receives in payroll taxes.

The ‘Early Claimers’

Another element of America’s income deficit problem is the “early claimers.” These are the people who have been forced to collect their Social Security benefits sooner than planned. Most of the early claimers are retirement age but are either unemployed or work part-time. Others have completely exhausted their savings.

The Center for Retirement Research at Boston College estimates that early claimers experienced a 4.6% decline in benefits or a monthly reduction of Social Security benefit checks by $56. While a 4.6% decline might not seem like much, it’s a lot to be losing for income strapped people with no other significant source of income.

The Fed’s Contributing Role

The Federal Reserve Bank’s low interest rates have contributed to the financial conundrum facing American’s income investors. The other part of their income source -- the money they’ve invested in dividend paying stocks (DVY) and treasury bonds (TLT) isn’t generating the same generous cash flow it once did.

As a result of low rates, the Fed has forced income savers to take greater risks with their money. Previously risk-averse investors recently have been piling into high risk areas like junk bonds (HYG) and exotic emerging market debt (PCY).

Are today’s yields compensating them for all of that risk? Time will tell, but the answer is probably no.

Attacking the Problem

Advisors should help their clients -– especially those under 50 -- to not make Social Security payments a major piece of their retirement income puzzle. By the time these people are ready to collect, there’s a good chance Social Security benefits will be radically altered or nonexistent.

Some advisors have added alternative income strategies like selling covered calls on their clients stock and ETF holdings. This is a conservative strategy designed to generate additional income beyond dividends and in choppy markets can be very effective.

Other advisors have added a layered approach to helping solve their clients’ income problem using guaranteed annuity income.

Whatever you decide to do with your clients, be proactive by helping clients to solve their income deficit problem. And while you’re at it, help them to appreciate the good old days of super-sized Social Security income benefits are long over.

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Ron DeLegge is the Editor of ETFguide.com and author of Gents with No Cents: A Closer Look at Wall Street, its Customers, Financial Regulators and the Media (Half Full Publishing, 2011).